GrainCorp board reaps what it sowed

Bad corporate governance is the real story behind the failure of the $3 billion Archer Daniels Midland takeover of
GrainCorp
. While Treasurer
Joe Hockey
deserves to be criticised for his confusing and somewhat opaque explanation for the rejection, the real criticism should be directed at GrainCorp chairman
Don Taylor
.

Taylor and his fellow board members were too greedy when it came to selling the company. The board’s unwillingness to accept a generous offer from ADM in November last year of $12.20 a share set the scene for the rejection that occurred on Friday.

GrainCorp failed to recognise the value that was put on the table by ADM for a company with a track record of volatile earnings because of seasonal fluctuations in grain crops.

Agricultural businesses have traditionally traded at lower earnings multiples compared to industrial companies because of that seasonal volatility.

GrainCorp chief executive
Alison Watkins
deserves enormous credit for making acquisitions in oilseeds and malt in a bid to diversify the earnings of the company.

She managed to slash the company’s heavy reliance on storage and logistics to 45 per cent of earnings in the latest full-year result, from 75 per cent of earnings in 2009. She expanded into oils, which now account for 25 per cent of earnings.

But she could not escape the seasonal volatility of wheat production, which this year is affected by drought in northern NSW and Queensland.

When ADM chairman and chief executive Patricia Woertz knocked on the GrainCorp boardroom door in October last year with an offer of $11.75, Taylor and his fellow directors should have immediately engaged.

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They failed to realise the political significance of what was being proposed, even though they had witnessed AWB and ABB pass into foreign ownership.

As the last significant agribusiness with control of certain infrastructure pinch points, the ADM bid was bound to be problematic with rural politicians and grain growers.

Political advantage lost

The board also should have realised the perverse feature of Australian politics that Labor governments rarely reject foreign takeovers. Labor is fearful of the business backlash and the danger of confirming fears of sovereign risk among foreign investors.

With that background in mind, the board of GrainCorp owed it to its shareholders to get a deal done as quickly as possible.

Instead of agreeing a price and then launching a campaign to win over the obvious detractors, the board squeezed ADM for more.

It has become obvious from the ADM deal and the
Warrnambool Cheese
takeover that foreign buyers place a much higher value on agricultural assets than Australia’s domestic institutions.

In that sense, ADM could be relied on to pay more, but the board of GrainCorp should have considered the trade-off between the time taken to get a higher price and the level of increase in political risk.

In the end, ADM paid 8 per cent more than the second offer price of $12.20, but the risks probably went up tenfold. Winning a takeover price of $13.20 gave the opponents an extra six months to get organised.

Matters were complicated even further with the move into the election cycle and the change of leadership from
Julia Gillard
to
Kevin Rudd
, which caused a change in Treasurer from
Wayne Swan
to
Chris Bowen
.

We know from comments made on Friday and in the past two weeks that Bowen would have approved it. But the raw politics suggest he was happy to leave it to Hockey and watch him squirm.

The next phase of this will be the gradual decline in the market value of GrainCorp, and with that will come the gradual decline in services offered to grain growers.

Investments unlikely

We know for a fact that $250 million in additional investment in the east coast grain storage and logistics networks promised by ADM during the takeover bid will not go ahead.

ADM has been given permission to lift its stake in GrainCorp to 24.9 per cent. But there is no investment case for ADM tipping $250 million into rail and silo assets here without the benefit of vertical integration.

What’s worse for the grain growers is that the promised $250 million that was going to be spent by GrainCorp on upgrading its network is no longer certain. Taylor made this clear in an interview with The Australian Financial Review published on Friday.

He said the investment could be delayed or spent elsewhere. “We have to be very careful about capital allocation," Taylor said.

Taylor is highlighting the fact that, without a takeover premium, GrainCorp’s ability to raise capital is severely restrained.

Hockey’s decision wiped about $588 million from GrainCorp’s market value. Another way to look at it is that the currency of GrainCorp shares plunged 21 per cent.

Grain growers celebrating victory against the evil American grain trader and processor need to be reminded that 80 per cent of the grain volumes pushed through GrainCorp go through 100 of the 280 storage sites.

That leaves about 180 silos that are marginal or loss-making. Following the ADM rejection, these sites will be reviewed and it is almost certain many will close.

Olive branch a ‘poisoned chalice’

Hockey’s olive branch to ADM’s Woertz was to allow the company to lift its holding in GrainCorp from 19.85 per cent to 24.9 per cent.

The Treasurer said this was to “encourage ADM to demonstrate its commitment to the Australian grains industry through its continued ­investment in GrainCorp". But this is not an olive branch – it is potentially a poisoned chalice for GrainCorp.

Now that it owns a quarter of the company, ADM will be able to throw its weight around whenever discussion turns to capital investment, future strategy and maximising returns to shareholders.

Those sorts of discussions will become more intense in the year ahead. Earnings before interest, tax, depreciation and amortisation are tipped to fall from $395 million to $338 million in 2014.

There are some who believe $338 million is optimistic.

ADM knows from Hockey’s statement on Friday that it has government support to become more active in the Australian market.

Hockey said the bigger ADM shareholding in GrainCorp would “provide a platform for ADM to build stakeholder support for potentially greater participation in the Australian industry as it develops".

The company is under earnings pressure because of increased competition in its core markets.

This leads to one of the great ironies of the ADM rejection. GrainCorp’s ­storage and logistics business is under pressure because it faces stiff competition in the areas where wheat crops are thriving, in southern NSW and ­Victoria.

Competition is squeezing GrainCorp’s profit margins at the very time that Nationals politicians claim the company is a grain sector monopolist.

ADM and GrainCorp’s failure to dispel that monopoly accusation is the other failing in the GrainCorp debacle.